Investors must be wary of courtroom minefields

Newcrest Mining
made news on Tuesday when the Land and Environment Court in NSW rendered a valuable exploration license in the Cadia Valley invalid.

The impact on Newcrest’s operations in the valley, which includes Australia’s biggest underground mine, is unclear.

For many shareholders, this judgment would have come as a surprise.

This is one of five cases being brought by small explorer
Gold and Copper Resources
, yet Newcrest has told shareholders little about the cases and has not disclosed any details in a contingent liability note.

Unfortunately, the Newcrest case is not an outlier. Even if companies acknowledge the existence of litigation, they are loath to give details for fear that any disclosure might prejudice the outcome or undermine settlement negotiations.

In the meantime, shareholders are exposed to potentially large liabilities with minimal information.

Our review of current court cases showed one in seven companies in the S&P/ASX300 is involved in litigation that could materially impact profit in the coming years.

Plaintiffs are seeking between 800 per cent of net profit and 5 per cent of net profit from 41 companies. Some cases involve claims so large that if they settle or run to judgment, they could absorb entire cash reserves, force a capital raising, or trigger debt covenants.

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Investors may assume liabilities will be covered by insurance, but history suggests that cover will be minimal. Our investigation of large court cases involving listed companies since 2008 revealed that the average insurance contribution to material settlements or judgments was just 10.8 per cent. However, having comprehensively reviewed all litigation involving S&P/ASX300 companies, we are concerned about the level of disclosure being provided to shareholders. With large court cases often in the media and only some court documents accessible, there is substantial information asymmetry among investors. Those with resources and legal expertise can investigate claims and assess the potential liabilities for themselves. Other investors are disadvantaged.

Take the recent bid-rigging case involving
Bradken
. The company (together with its chairman and chief executive, who were parties to the action) were found to have breached two provisions in the Consumer and Competition Act in 2011 and ordered to pay $US25.4 million, 24 per cent of its previous year’s profit.

Bradken did not disclose the case was afoot until five weeks before judgment. It appears that some in the market understood what was at stake well before the judgment and subsequent disclosure. Short-sellers were active in the stock several weeks before the hearing began. Net short positions rose from about 3 per cent of shares on issue to about 7 per cent of shares on issue during October and November 2012. This was the period when mediation between the parties failed and evidence was being heard at the Federal Court trial. There were no price-sensitive announcements made to the ASX during this period. Bradken is appealing the decision.

The regularity of “earnings surprise’" from litigation suggests that companies aren’t adept at achieving a balance between protection of their legal position and the investors’ right to material information. Ownership Matters is calling on ASIC to issue a guidance note clarifying companies’ obligations to disclose litigation events as contingent liabilities.

If companies provide a few key details in contingent liability notes, such as the size of the claim and whether an insurance policy is in existence, investors would be operating on an even playing field. This requirement would co-exist with the continuous disclosure regime, but reduce the capacity for unpleasant surprises from litigation.